“Entrepreneurship is about acquiring skills, beliefs, and character traits. To advance, I find that we must determine which skills, beliefs, and character traits we lack. Most times, we simply need to improve.” - Alex Hormozi
In this blog post, we will discuss a powerful equation that Alex Hormozi uses to analyze businesses. By understanding this equation, you can assess your own business and make the necessary changes to maximize your growth potential.
This equation uses six key metrics: New Sales per month, Revenue, Price, Churn, Lifetime Value, and Gross Profit. Let's break down the equation using a hypothetical example from Alex's Video. You can also watch here and read along!
New sales per month: The number of new clients you are acquiring each month. In our example, the business was getting 100 new sales per month.
Revenue: The total income generated by your business. The example business was making $400,000 in revenue.
Price: The amount you charge for your product or service. In the example, the price was $1,000 per month.
Churn: The percentage of clients who cancel their subscription or stop using your product/service each month. Most businesses don't know this number.
Lifetime value (LTV): The total revenue generated by a client during their entire relationship with your business. Most businesses don't know this number.
Gross profit: The revenue remaining after deducting the cost of goods sold. In the example, the business had a 90% gross margin.
In the example, 13 clients were canceling per week, which equates to roughly 50 clients per month. To calculate churn, divide the number of clients canceling per month (50) by the total number of active clients (380).
(50 / 380) * 100% = 13%
In this case, the churn rate is 13%.
To calculate LTV, divide the price per client per month ($1,000) by the churn rate (13%).
$1,000 / 0.13 = $7,692
The resulting LTV is approximately $7,700 per customer.
Based on the current LTV, current rate of new customers, and current rate of churn the business would cap out at $770,000 per month, or around $9 million per year.
100 * $7,700 = $770,000
$770,000 *12 (months) = $9,240,000
This hypothetical cap helps you analyze the potential opportunity of the business based on current metrics.
By determining the LifeTime Gross Profit, we can determine exactly how much we can afford to spend to acquire a customer.
In this example, the $1000/m client only cost roughly $100 per month to service.
$1000 - $100 = $900
$900 / $1,000 = .9 or 90%.
$7700 (LTV) * .9 = $6,930
The approximate Gross Lifetime Profit is $7000.
"Which means as long as we're spending less than $7,000 to get a customer, we're going to grow!"
To grow your business, you can either acquire more customers or increase their LTV.
In the example, Alex identified an opportunity to reduce churn as a means to increase LTV.
By reducing the churn rate from 13% to 3%, the LTV would increase to $33,000 per customer, raising the hypothetical cap to $3.3 million per month. Without changing anything else.
$1,000 / 0.03 = $33,333
By understanding your business's metrics and identifying its weak points, you can focus on removing constraints to unleash its growth potential. The objective is to turn a low-value business into a high-value one by optimizing growth, stickiness, and profitability.
In this example... it would be much more valuable to REDUCE CHURN than to ACQUIRE MORE Customers.
By understanding this powerful equation and applying it to your own business, you can quickly assess your company's strengths and weaknesses and take the necessary steps to optimize its growth. By knowing your metrics and removing constraints, you can unlock your business's full potential and achieve success.
In MediaTeam.app we've created the Offer Machine™ using this video and Alex's Principles in $100M Offers to bring equations like this to life and use them in your brand!